Another Alex Jones Entity Seeks Bankruptcy Protection

 Faced with pending trials to establish liability for defamation, another Alex Jones entity has decided to test the waters of bankruptcy. On Friday July 29, 2022, Free Speech Systems, LLC, the company which actually produces the Alex Jones Show and his other programming, filed a petition under Subchapter V of Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas, Victoria Division. Case No. 22-60043.  In April, three minor entities within the Jones organization filed bankruptcy in an attempt to channel liability away from Jones and Free Speech Solutions. Those cases met substantial resistance and were voluntarily dismissed. 

NCBJ 2021: Legislative Wish Lists and Realities

This is a combination of two programs. One of the NCBJ plenary sessions offered a Shark Tank like program where three lawyers pitched their proposals to reform the Bankruptcy Code. Meanwhile, at the ABI luncheon, Bill Brandt and Robert Keach offered their prognostications as to what might actually change in the Code. Since both programs involved legislation, I have chosen to combine them here. As you read through this article, you should note that the first part contains the idealism of would-be reformers while the second part contains the realpolitik. 

Shark Tank

Student Loans

In the first program, John Rao of the National Consumer Law Center offered his proposal to amend 11 U.S.C. Sec. 523(a)(8) to rollback dischargeability of student loans to the law as it existed in in 1998 when student loans could be discharged after seven years or on a showing of undue hardship.  He said that the seven-year period deals with the concern that people can come straight out of school and file bankruptcy. He said it's not a complete solution. He said we still need to deal with cost of higher education. 

To make the case for change, he gave the illustration of Karen in Arkansas. She borrowed $10,000 thirty years ago. She never used her degree. Over thirty years, she paid $20,000 but still owed $106,000. Mr. Rao said that there is something fundamentally broken with a system if that is how we treat our debtors. Now the federal student loan creditors can garnish her Social Security and tax refunds and even the Earned Income Tax Credit. There is no statute of limitations on federal student loans so her debts will only disappear when she dies. 

Why did Congress change the law?  (Congress changed the law in 2005 to add some private student loans to the list of non-dischargeable debts and eliminate the ability to discharge student loans after seven years). He pointed out that there was not a single Congressional hearing or GAO report on abuse. He characterized the change in law as a Congressional gimmick to balance the budget. 

Mr. Rao was asked if his proposal would protect the public fisc. There are $1.7 trillion in federal student loans. Why not require payment of disposable income over period?

Mr. Rao responded that most debts are performing. Only about 10% in default. There is no evidence that denying discharge increases revenues to government. Instead, the federal government can capitalize the interest and seek returns that would make a predatory lender blush. The problem with requiring debtors to complete a chapter 13 is that about 50% of Chapter 13 debtors never get a discharge.

Mr. Rao was asked about his proposal to leave undue hardship in in his proposal. He was asked whether it be better to have objective criteria for undue hardship. Mr. Rao said that objective criteria would help but we already have a workable standard for undue hardship in connection with reaffirmation agreements and it would make sense to use that standard. However, he pointed out that the debtors who need relief the most can't afford to litigate. 

He was asked whether his proposal would roil the markets. Wouldn't lenders increase the price to address the risk? He pointed out that the pricing only affects private lenders. When private loans were made non-dischargeable in 2005 there was either no decrease in rates or an actual increase based on different studies.

President Biden has proposed cancelling some student loan debt. Doing this would be a stimulus to economy according to Moody's as more people would be able to buy homes and have children. However, requiring bankruptcy to get that cancellation would avoid the moral hazard of general cancellation. 

KERPs

 

Metta Kurth pitched a proposal to close loopholes to BACPA's limitations on "pay to stay." She called her proposal "stop the heist." In 2005, BAPCPA limited Key Employee Retention Programs ("KERPs") by requiring that a company demonstrate three things: that the person receiving the KERP has received a better offer, that their services are essential and that the amount of the KERP is either not more than 10 times the mean amount paid to non-management employees for similar purposes or, if no similar amounts were paid out in the prior year, it did not exceed 25% of any similar payment made to an insider during the prior year. 11 U.S.C. Sec. 503(c).     

Some companies shifted away from KERPs and went to "keeps," incentive payments to be earned for meeting certain benchmarks. Ms. Kurth said that "keeps" had a greater sense of integrity. However, other companies made an end run around the KERP rules by simply making these payments pre-petition. She gave the example of JC Penney which paid out $7.5 million to four executive five days before the petition. 

Ms. Kurth proposed to amend 11 U.S.C. Sec. 548 in three ways:

(a) Existing Sec. 548(a)(1)(B)(ii)(IV) states that insider compensation given for less than reasonably equivalent value and outside of the ordinary course of business can be recovered as a fraudulent transfer. She would extend this to apply to all insider compensation given during the 90 days before bankruptcy.

(b)  She would also add a provision that insider compensation would be presumed to be for less than reasonably equivalent value if it was greater than the normal pre-bankruptcy compensation and did not meet the requirement for a KERP; and

(c)  Make non-dissenting directors who approve compensation in violation of this provision liable similar to state laws applicable to illegal dividends. 

She was asked if companies would just give out insider bonuses 91 days before bankruptcy if her proposal was adopted. She answered that the petition date is often fluid and that 90 days will catch most abuse. 

She said that her proposal would motivate companies to use a "keep" or stay within guardrails for KERPs during the runup to the petition.

She acknowledged that her proposal would not fix the imbalance in executive compensation. 20 years ago, executives earned 70 times the wage of their typical worker while today that ratio is now 200 times.

She said that she was not trying to fix entire system, just the perception of abuse.

(Ed.: While I admire Ms. Kurth's enthusiasm, her proposal would continue the trend of making the Bankruptcy Code resemble the Tax Code in its complexity. The problem with ever more specific prohibitions is that ever more clever lawyers will find ways around them. To be very clear, she had identified a very real and very serious problem. My quibble is with the specifics of her proposal rather than the need for it)

The Means Test

Eric Brunstad proposing the means test as the gateway for determining substantial abuse. He proposed going back to the standard existing before BAPCPA when Bankruptcy Judges had discretion to find substantial abuse based on the circumstances of the case rather than a statutory presumption. 

He said that the means test was a solution in search of a problem that never existed and a bad solution at that.

He said that judges know abuse when they see it and have ample tools to address it when it actually arises.

He asked the rhetorical question of where did the means test come from? He said it came from the history of credit card underwriting. At one time, credit card underwriting was done on an individual basis. Then it went to a portfolio underwriting system. The model predicted 4% default rate. As time went on, credit cards became less profitable. He said that the credit card companies wanted to squeeze a couple more bucks out of the system by making bankruptcy more difficult and expensive to pursue. (Ed. Prof. Ronald Mann described this as the "sweatbox" in an influential paper). 

He said that the means test was a very inefficient solution. If you are $1 above the test, you are deemed to be a substantial abuse. 

Prof. Brunstad said that the empirical data said abuse was not out there. He also said that a one size fits all test was not useful. He quoted Tolstoy who said, "All happy families are alike; each unhappy family is unhappy in its own way.” He said that by analogy, every abusive debtor is abusive in its own way. 

He stressed that there was not a problem with too many people filing bankruptcy. According to Sen. Elizabeth Warren, 43 million people were in financial distress after the Great Recession, but only 1.5 million filed bankruptcy.  He said that people do not file for bankruptcy willy-nilly

He repeated the proverb that you can't get blood out of stone and then described the means test as a very expensive blood test for the stone.

He said that this kind of discretionary thing (i.e., ferreting out abuse) is what bankruptcy judges are paid to do.

He also said that there is a huge externality problem. He asked who gets the benefit and who bears the cost? The credit card companies reap the benefit from debtors who continue to pay because they cannot afford to file bankruptcy. The cost is borne by higher fees paid by debtors. He said that if a debtor is required to file chapter 13, it is like a 25% tax. 

In the end, the audience voted to invest in all three proposals. Unfortunately, legislative reform depends on a dysfunctional Congress, not what bankruptcy judges and professionals would like to see. That offer a nice segue into the second legislative program I watched.

ABI's Program on Legislative Likelihoods

The three proposals contained in the Shark Tank program were each thought provoking. However, when the American Bankruptcy Institute put on a program on likely changes to legislation, it focused on different proposals altogether. Bill Brandt and Robert Keach are both ABI members who have been active in proposing legislation. Although ABI does not take positions on legislative as a group, its individual members have been active in lobbying Congress. I want to stress that the very opinionated and outspoken Mr. Brandt and Mr. Keach were speaking for themselves rather than for the ABI as an institution. 

SubChapter V

Mr. Brandt started the conversation off with discussion of SubChapter V. He said that when it was passed, the debt limit of $2.7 million was too low. Shortly after it was passed, they were able to increase the limit to $7.5 million but only on a temporary basis. Now he said that the goal would be to increase the limit to $20 million. However, at higher limits, SubChapter V would take on more of a hybrid nature. He said that U.S. Trustee fees would need to kick in at somewhere between $7.5 million to $10.0 million to keep the program funded. He also said that legislation would likely give courts the option to have a creditors' committee beginning at $12-$15 million.

He said that if the debt limit was increase to $20 million, it would cover 95% of Chapter 11 cases. He said that this would take the wind out of the venue issue, which he described as "our abortion issue."

This raises two very interesting questions. Was he assuming that mega SubChapter V cases would not be forum shopped? If the law allows forum shopping and litigants see an advantage to doing so, why would they stop? Also, it wouldn't address the problem of the large public companies seeking out favorable venues to the detriment of smaller creditors, employees, retirees and other constituencies. Also, as a Texan, I am very familiar with the emotions triggered by abortion. On the one hand are those with moral certainty about the importance of lives as yet unborn while on the other there is the moral certainty of those who want to control their own bodies. Abortion stirs the outrage of moral certainty in its combatants. Is bankruptcy venue really that divisive or was Mr. Brandt merely engaging in hyperbole?

 Mr. Keach acknowledged that he had lost the debate over having a facilitating trustee in SubChapter V and that it was good that he lost. He described the trustee as one of the reasons why the Small Business Reorganization Act has worked so well.

Mr. Brandt said that raising the SubV debt limit could make its way into a reconciliation bill because it would raise fees. He also explained that because the support of Sen. Grassley was critical that SubChapter V was intentionally made similar to Chapter 12.

Venue

Mr. Brandt had a very cynical view on venue reform. He said that with this President and Rep. Nadler chairing the House Judiciary Committee, venue would be a non-starter. He said that venue was a good way for Sen. Cornyn and Sen. Warren to raise a lot of money but that it would not be a factor for the balance of this decade.

Mr. Keach said that the option to allow affiliate filings was designed to placate New York bankruptcy lawyers but "no one in New York believes that."

(Ed.: Dissenting Opinion here. For the last three years, Sens. Cornyn and Warren have worked together on a venue bill. This year bills have been introduced into the Senate and House at an earlier stage with more co-sponsors than before. As cases like Purdue Pharma draw national outrage, bankruptcy venue will continue to build momentum. However, I must acknowledge that our scrappy, grass-roots crusade has very determined and well-organized opposition). 

Mr. Brandt said that there was a study that concluded that the bankruptcy industry had the same effect for the Delaware economy as having a minor league baseball team would have. He also said that having increased debt limits for SubChapter V would be a pretty good second choice for the venue reformers. 

Mr. Brandt noted that the fire for venue reform has weakened as the New York-Delaware duopoly has expanded to include Houston and Virginia. (Ed.: Dallas, TX, Corpus Christi, TX and Charlotte, N.C. have also been the recipients of recent attempts at forum shopping. Will forum shopping become so widespread as to draw a collective "meh" from the bar? As the blogger, I get to ask the questions, but I honestly don't have an answer).

He said that 10-15% of the Senate will always oppose venue reform making it an uphill battle. 

He also said that another needed reform would be to allow a single asset real estate debtor to be a SubV debtor if it was a landlord to a small business debtor.

Third Party Releases

Mr. Keach mentioned that when Jon Oliver did a program on third party releases, he had a researcher spend an hour with Mr. Keach. He said that Mr. Oliver gave the issue a very serious presentation. He then said that the issue was not going anywhere. He characterized it as a solution in search of a problem. He said that it was not the bankruptcy system that was broken but the tort system. He said that bankruptcy delivers money to victims faster and more efficiently than the tort system. He said that it is easy to forget that what we are about is compensating people. He said that if you want to punish people, prosecute them. "If you can't prosecute them, then shut up."

Mr. Brandt said that legislation barring third party releases even with an opt out were going nowhere. He said it was a chance for Democrats to say that they voted against Darth Vader. 

Student Loans

Mr. Brandt said that the Fresh Start Bill proposed by Sen. Dick Durbin is the closest bill that might actually achieve passage. It would reinstate dischargeability after ten years and is close to the ABI Commission's proposal. However, he said it was "probably not a this year thing." He added that bankruptcy reform always starts out with consumer provisions. He indicated that it would not be this Congress. Probably the next Congress or the one after that and it would be part of a bill with lots of ornaments on it.

He said that one problem with achieving bankruptcy reform is that there is not an association of past and future debtors but that student loan borrowers vote. Unfortunately, they cannot afford campaign contributions. 

Mr. Keach said that the purveyors of private student loans hired really good lobbyists in the past but that maybe the problem is becoming too significant to ignore.

Final Thought: I really appreciated the fact that Mr. Brandt and Mr. Keach didn't pull any punches. I may not have agreed with them, but they certainly gave their unvarnished opinions without resorting to polite euphemisms. 

NCBJ 2021: Even the Circuits Can't Agree

 ABI Editor at Large Bill Rochelle hosted a group of three panels discussing three different legal issues. The issues included one legitimate circuit split, a dispute between lower courts and a divided state court panel.

Recharacterization

Issue one was whether recharacterization of debt is an issue of state or federal law. Recharacterization is where an obligation nominally characterized as a debt is recharacterized to be an equity contribution.  Recharacterization was first recognized in the Supreme Court case of  Pepper v. Litton, 308 U.S. 295 (1938). The Third, Fourth, Sixth, Tenth and Eleventh Circuits all state that the issue is one of federal law while the Fifth and Ninth Circuits hold that it is a matter of state law.  

Sens. Warren and Cornyn Tackle Bankruptcy Venue Again

 The bipartisan duo of Sen. John Cornyn from Texas and Sen. Elizabeth Warren from Massachusetts have introduced a new bill tackling bankruptcy venue. The Bankruptcy Venue Reform Act of 2021, which can be found here, is the latest attempt by the Senators to level the bankruptcy playing field. The new bill, which is supported by the Commercial Law League of America and a national network of insolvency professionals, expands upon the Senators prior work.

A Renewed Sense of Purpose

The bill contains a new set of findings and statement of purpose.

NRA Filing Illustrates Venue Loophole for Chapter 11 Filers

The National Rifle Association likes guns. Texans like guns. Therefore, when the NRA decided to file bankruptcy, there was a certain logic to filing in Texas. Unfortunately, however, prior to November 24, 2020, the NRA had no legal right to file bankruptcy in Texas. This did not deter the gun rights advocates. They created one.

Let me explain how this works. Under the bankruptcy venue statute, 28 U.S.C. Sec. 1408(a), a debtor can file bankruptcy in its domicile, residence, principal place of business or where its principal assets in the United States were located during the preceding 180 days. The NRA did not meet any of these tests. It is incorporated in New York. Its principal place of business and presumably principal assets are located in Virginia. However Sec. 1408(b) offers a loophole. A company can file in a district where a bankruptcy by one of its affiliates is pending. An affiliate includes a company owned by the debtor.

Bankruptcy Court Denies Request to Transfer Case to Delaware

The venue reform movement has focused on cases filed in Delaware and the Southern District of New York which are either not transferred (Enron and Energy Futures) or transferred at considerable time and expense (Patriot Coal).   However, a decision out of Texas denied a request to transfer an adversary proceeding to Delaware.    Think3 Litigation Trust v. Zuccarello (In re Think3, Inc.), No. 13-1081 (Bankr. W.D. Tex. 1/4/15), which can be found here.

What Happened

The Think3, Inc. case was unusual in more ways than one.    Think3 was incorporated in Delaware and had a large branch office in Italy.   An involuntary bankruptcy proceeding was filed against the company in Italy.   The Debtor filed a voluntary chapter 11 petition in Texas on May 18, 2011.   The Italian Trustee filed a Chapter 15 petition in Texas later the same year; however, recognition was denied and the petition was dismissed.  

The voluntary chapter 11 case resulted in a confirmed plan with a Litigation Trust.    The Litigation Trust sued certain former officers and directors, four of whom were residents of other countries, primarily Italy.   The intrepid Litigation Trustee was able to serve the foreign defendants through the Hague Convention.     

The Defendants brought motions to dismiss for failure to state a cause of action and motions to transfer venue.   The Court's ruling on the motions to dismiss contains an excellent discussion of Rule 12(b)(6) as well as Delaware breach of fiduciary duty law.  (The Court actually discusses all nine causes of action in great detail, but I stopped reading after breach of fiduciary duty).  Nevertheless, what interested me was the motion to transfer venue.    

The Motion to Transfer Venue

According to Judge Mott:

(T)he Director Defendants (Defendants Zuccarello, Costello, Kaufmann and Perry) have requested this Court to transfer venue of this adversary proceeding to the U.S. District Court for the District of Delaware.11 In support, the Director Defendants primarily rely on Think3’s incorporation in Delaware and the resulting application of Delaware corporate law to many disputes in this proceeding. However, without more, the Director Defendants have failed to meet their burden to demonstrate that transfer of venue to Delaware is warranted.

Opinion, p. 53.  

The Bankruptcy Court started with the presumption that the adversary proceeding belonged in the Court where the main proceeding had its venue.     It then cited a six factor test as follows:

(a) Efficiency and economics of estate administration;
(b) Presumption in favor of the “home court”;
(c) Judicial economy and efficiency;
(d) Fairness and the ability to receive a fair trial;
(e) The state’s interest in having local controversies decided within its borders; and
(f) Plaintiff’s original choice of forum.

The Court found that five out of six factors weighed in favor of retaining the case in the Western District of Texas.   Of course, the test seems to be weighted in favor of retaining venue.   Two of the six factors, the presumption in favor of the home court and the Plaintiff's original choice of forum , will always favor keeping the case.   The ability to receive a fair trial is a factor unlikely to arise in a bankruptcy setting.   As a result, the six factor test really boils down to efficiency and economics of estate administration, judicial economy and efficiency and the state's interest in having local controversies decided within its borders.

In its discussion of judicial economy and efficiency, the Court found that applying Delaware corporate law was not a major concern.

The primary thrust advanced by the Director Defendants in support of venue transfer is that substantive issues of Delaware corporate law are involved in this adversary proceeding, which would best be handled by a Delaware court. However, the “learning curve” of Delaware corporate law is not as great as the Director Defendants suggest. Bankruptcy courts are regularly called upon to decide issues of corporate law of another state. Indeed, Texas bankruptcy courts are often required to interpret Delaware corporate law; just as Delaware bankruptcy courts are often required to interpret Texas law.

Opinion, p. 55.   Although Judge Mott spent his legal career based in El Paso, Texas, he had a national practice.   As a result, having to apply Delaware corporate law does not appear to have bene a daunting task.   Indeed, due to the ubiquity of Delaware incorporation, there are probably a great many lawyers versed in Delaware corporate law who do not practice in Delaware. 

This case could well have originated in Delaware and remained there.    Because the company was incorporated in Delaware, current law would have permitted a filing there.   Had the main case been filed in Delaware, the presumption would have been that the adversary proceeding should have been filed there as well.   However, because the main case was filed in Texas, the presumption was in favor of Texas venue and here the case remained.   

The Difficulty With Multi-Part Tests for Venue

Interestingly, there are as many multiple factor tests for transfer of venue as there are cases.   In re BDRC Lofts, Ltd., No. 12-11559 (Bankr. W.D. Tex. 2012), an opinion by Judge Craig Gargotta which was partially relied upon by the Court in the Think3 opinion, contained a wider list of factors to consider, including:

1.  Efficient Administration of the Estate;
2.  Judicial Economy;
3.  Timeliness;
4.  Fairness;
5.  Proximity of creditors;
6.  Proximity of the debtor;
7.  Proximity of witnesses;
8.  the location of the assets;
9.  whether transfer will promote the economic administration of the estae;
10.  the necessity for ancillary administration.

BDRC was an opinion dealing with transfer of a main case rather than an adversary proceeding.  As a result, it was necessary to massage the factors some.

A recent opinion by Judge Marvin Isgur divided the factors into public and private and discounted the plaintiff's choice of filing.

The private factors are: (1) ease of access to sources of proof; (2) availability of compulsory process to secure attendance of witnesses; (3) cost of attendance for willing witnesses; and (4) all other problems related to ease, expeditiousness and expense of trial. The public factors are: (1) administrative difficulties because of court congestion; (2) local interest in having local cases decided at home; (3) familiarity of the forum with governing law; and (4) avoidance of conflicts of law problems or applying foreign law. No single factor is dispositive and the factors are not exhaustive. Rather district courts have discretion to adjudicate motions to transfer venue on a case-by-case basis.

Additionally, the Fifth Circuit has held that a party's choice of forum should be given little, if any weight in venue analysis.

In re Charles Michael Lucas, 2012 Bankr. LEXIS 5067 (Bankr. S.D. Tex. 2012) at *7-8.

With all of these tests out there, it raises the question of whether they are useful at all.  28 U.S.C. Sec. 1412 identifies two factors to be considered:  the convenience of the parties and the interest of justice.   Rather than developing elaborate lists of factors to be considered, it might be just as easy to tick off the specific facts that weighed into convenience of the parties and the interest of justice.   While it would not look as precise as a six or eight or ten factor test, it could be just as useful, especially when the multipart tests all allow the court to give more weight to whatever factors it deems most important.  Such a fluid test is more of an illusion than a clear standard.      

Final Note

 Having written an epic, 58-page opinion, Judge Mott concluded with a similarly epic conclusion.  He wrote:

When viewed through the restrictive prism that Rule 12(b)(6) requires, much of Plaintiff Trust’s Complaint will survive until another day. The Court realizes that there will be another side to the story told in the Complaint–and that facts and proof (not just allegations and plausibility) will ultimately govern the outcome. There are mountains to be climbed and defenses to be scaled for Plaintiff Trust to ultimately prevail. Equally evident is that the Defendants will be forced to defend this suit and their actions in what they likely consider to be a faraway land.

This arduous preliminary skirmish, which involved hundreds of pages of pleadings and countless hours of effort, has now come to the end. The Court will enter a separate Order on the Motions To Dismiss under Rule 12(b)(6) filed by the Defendants consistent with this Opinion, and denying the request to transfer venue to Delaware. The Court will also enter an Order requiring the parties to conduct a planning conference and submit a proposed scheduling order, so that the discovery stage of this proceeding can commence.

Opinion, p. 58.    Judge Mott often employs a well thought out turn of phrase in his opinions, as well as quotes from films and popular music.   I am glad that I finally had a chance to feature one of his writings.   

The Short Case for Venue Reform

Today I had the opportunity to debate venue reform at the National Conference of Bankruptcy Judges in Chicago.   We had two excellent teams of debaters.   Arguing for the pro-reform position were Prof. Samir Parikh, retired Bankruptcy Judge Leif Clark and myself.   The pro-status quo team consisted of Prof. Douglas Baird, retired Bankruptcy Judge Arthur Gonzalez and Dan DeFranceschi of Richards, Layton & Finger, P.A.   Jamie Sprayregen of Kirkland & Ellis moderated the debate.  We had a good, vigorous debate.     There was at least some agreement that venue for preference actions should be reformed.    The debate was sponsored by the Commercial Law League of America.

Here is the opening statement that I gave for the pro-reform side:

Good afternoon, my name is Steve Sather. My colleagues, retired Bankruptcy Judge Leif Clark and Prof. Samir Parikh and I will be arguing that the current bankruptcy venue law, 28 U.S.C. § 1408, should be reformed to prevent forum shopping in Chapter 11 cases.

By forum shopping we mean filing in a venue where the company has little or no physical presence.   Examples would include the Los Angeles Dodgers and the Chicago Tribune filing bankruptcy in Delaware.

Forum shopping is allowed by the current law for two main reasons.  First, by equating domicile with state of incorporation, the courts have allowed companies to file in jurisdictions that have little to do with their actual business operations.   Second, by allowing venue where there is a case concerning an affiliate, venue for an entire corporate group can be based on the locale of a minor subsidiary or even one created for the purpose of obtaining venue.

   Judge Leif Clark, Prof. Samir Parikh and Steve Sather debate at NCBJ
 
Forum shopping occurs with great regularity.   Prof. Parikh’s study found that 69% of large companies that filed chapter 11 during the Great Recession forum shopped.   This is not just happening in Delaware and New York.   Pilgrim’s Pride, ASARCO and Crescent Resources are all examples of cases that were forum shopped to my home state of Texas.   It is not just happening in large cases either.  In a study by the Venue Reform Group, of which I am a member, half of the 559 out of state cases filed in Delaware since 2003 had less than $15 million in assets.   The current venue law is so open-ended that it has been referred to as a non-law.

Forum shopping is a problem because it confounds creditor expectations and deters participation by local parties.    Think of the City of Detroit case where Judge Steven Rhodes viewed the local community and allotted a full day for local residents to address the court.   That could not have happened if the case had been filed in Delaware.   When a bank or a trade creditor deals with American Airlines in Fort Worth, they know that they may have to go to Ft. Worth to enforce their debt.   However, they do not expect to have to hire local counsel in Delaware to defend a preference action. 

Forum shopping also creates the perception that the process is manipulated by insiders and major players to the detriment of small creditors.  When Enron filed in New York, it looked like the company was fleeing from its very public problems in Houston.   While Houston was good enough for the criminal trials of the Enron executives, the reorganization was held elsewhere.  Bankruptcy is big business and when it takes place far away from the home forum, we can expect the public to be skeptical of the process and the results.   I don’t blame the lawyers because they are simply taking advantage of the choices given to them under existing law, but the current process feeds the Wall Street vs. Main Street narrative that is dividing our country.

While we acknowledge that there are skilled and hard working judges in New York and Delaware, there are excellent judges all over the country and we see that in cases where forum shopping is not an option such as municipal bankruptcies and the Catholic Diocese cases.    Think Steven Rhodes with the City of Detroit or Susan Kelly with the Diocese of Milwaukee.   

In our discussion today, we will offer several solutions, including separate venue provisions for individuals and artificial entities, which was the rule immediately prior to enactment of the Code, reforming the affiliate venue rules, creating a national bankruptcy court of appeals and procedural reforms to ensure that venue issues are resolved promptly and efficiently and that forum shopping is deterred.

Note:  My original post referred to Dennis DeFranceschi.   His name is actually Dan, which I knew.  I apologize to both Dan and his parents for trying to rename him.

A Modest Proposal for Venue Reform

Lately there has been a lot of attention focused on venue reform including an ABI Commission hearing.   I have a simple proposal that would eliminate this problem once and for all.    My suggestion is to let each of the circuits compete for the big cases, say those with over $100 million in assets.    

Here is how it would work.   Each circuit would select one male and one female associate to compete in the Venue Games.   Delaware and the Southern District of New York would be counted as an additional circuit in order to bring the number of tributes to twenty-four. The tributes would then fight to the death in a televised competition taking place in a specially designed arena with hazards designed to kill off the weaker circuits.  In order to match current reality, the tributes from Delaware and New York would receive special training from the moment they were licensed to compete in the games.  

The winner of the game would be made a partner and given a corner office in a specially designed Victor's Tower and would be exempt from future games.   For the next year, all mega cases would be filed in the victor's court of choice.    Would this be an improvement over the current system?

(Disclaimer:  Any similarity between my proposal and a popular trilogy of young adult fiction books and movies is purely coincidental).   

Venue Takes Center Stage At ABI Commission Hearing (Austin Hearing Pt. 2)

Venue occupied the second half of the commission hearing held on November 22, 2013 and produced some of the liveliest discussion.  While there were five panelists slated to discuss venue, Judge Greendyke and Buzz Rochelle added their comments as well.   (I mention them here out of order for clarity of presentation).   

The Case for Reform

Former Judge Greendyke related his experiences with two Texas debtors that filed out of state.   He said that when Enron filed in New York, "I had to go to church and answer questions about why the company was filing there."   When American Airlines filed for bankruptcy in the same location, he expressed frustration that "you're going to have to rely on ABC News to find out what is going on."   

Mr. Rochelle emphasized that "chapter 11 needs to be seen and not just occur" and that "when it happens halfway across the country" this doesn't happen.  He emphasized the need for "the judge in the local community to make decisions."

First up on the venue panel was Judge Steven Rhodes from the Eastern District of Michigan. Judge Rhodes started with the "blunt observation" that:

The venue law we have is a venue non-law.   Any lawyer can figure out a way to file any case in any location.

Judge Rhodes urged the Commission to take a fresh look at the current "non-law" and to consider the purpose of venue laws.  He identified two key purposes as the interests of the parties and the institution as a whole.   He said that venue laws should "protect the parties who the moving party brings into court from inconvenience arising from choices made by" the debtor.    He said that the institutional purpose for venue laws was to provide legitimacy to the court and its proceedings.

He acknowledged that there were no perfect solutions in a world with multi-state and multi-national parties but said that "that doesn't excuse us from doing the best we can."    Judge Rhodes recommended principal place of business as the best solution for venue.

Judge Rhodes responded to the argument that concentrating cases in two forums creates predictability in how the law will be applied by saying that "if we had perfect predictability we wouldn't need judges."   He added that, "The biggest problem with predictability is that (people who use the term) mean predictability that I'm going to win."   He said that too much concentration reduces innovation and experimentation and thereby the opportunity to improve.  

He concluded with a plea for integrity.   He said:

Courts work because people have confidence they can send disputes to them, be heard and have a just result.   Everything that we do that enhances confidence needs to be encouraged.   Our non-law detracts from legitimacy.

Douglas Rosner of Goulston & Storrs in Boston testified on behalf of an ad hoc group of over 100 attorneys in 35 states seeking venue reform.   (Disclosure:   The Commercial Law League of America of which I am a member supports this effort and I helped Doug prepare for his testimony.).

Mr. Rosner laid out the statistical case for reform stating:

Substantial evidence demonstrates that a disproportionate number of chapter 11 cases are being filed in Delaware and New York which have little connection to those forums. A recent study by Associate Prof. Samir Parikh of Lewis & Clark School of Law found that 70% of large public companies that have filed bankruptcy in the last 5 years have forum shopped; 80% of which filed in Delaware or the Southern District of New York. Unlike the studies done in the mid-1990s, we know now that forum shopping affects companies of all sizes. In fact, almost half of the 559 out-of-state cases that filed in Delaware since 2003 had assets of less than fifteen million dollars and middle market companies comprise the vast majority of the filings in Delaware. The statistics demonstrate that chapter 11 debtors forum shop at such a staggering rate, it can no longer be ignored.

Rosner also gave examples from his home state of Massachusetts in which 33 companies with assets of over $6.2 billion and 65,000 employees filed in other states over a ten year period. Examples included Evergreen Solar, a company that received $58 million of assistance from Massachusetts, Polaroid, which drastically affected local employees and retirees, and Friendly Ice Cream, a cultural institution in Massachusetts for more than 75 years. (Ed.: Imagine the furor that would result if Bluebell filed for bankruptcy in Delaware).

Mr. Rosner also raised the specter of manipulation, pointing out that "The chapter 11 landscape is littered with examples of debtors trying to manufacture venue or using immaterial affiliates as a hook to establish venue."   

He also addressed creditor expectations, stating:

Prior to a bankruptcy filing, a debtor’s creditors and employees are used to dealing with the company’s headquarters. When they read in the papers that the company filed in another jurisdiction, their reaction is likely to be one of suspicion. They can reasonably question whether the company filed in a distant forum to obtain an advantage over other parties or discourage participation by local interests.

Mr. Rosner argued that the transfer of venue for Patriot Coal out of New York was not proof that the system is working.   He pointed out that the process took four months and millions of dollars in professional fees.   He quoted Bloomberg News for the prospect that Patriot Coal proved "the near impossibility of having venue transferred in large cases."

Next up was Prof. Jay Westbrook of the University of Texas School of Law who said he was delighted to see the attention being given to the venue issue.   Sounding a familiar theme, he said that:

Justice must not only be done; it must be seen to be done.   If not, the system fails in an important part of its social, political and economic role.

Prof. Westbrook argued that reform often comes from "spectacular trials or puzzling verdicts."   He said that "proceedings in a distant court will not receive the same coverage" as a local case would, being relegated to the financial press rather than the local media on which most people rely.   He also stated that when cases are filed closer to home, that local officials will be more likely to intervene.

He summed up his thoughts with the memorable phrase that when debtors are required to file in their principal place of business "the windows of justice will not be frosted by distance."

"There Is No Problem"

James Patton of Young, Conaway, Stargatt & Taylor in Delaware was the first of two witnesses favoring the status quo.   He argued that place of incorporation was the "only uncontestable standard" for venue and that a principal place of business requirement would lead to litigation such as encountered in Chapter 15 cases over the Center of Main Interest.   (The requirement in Chapter 15 cases that the proceeding be filed where the business has its main economic activity).  

Mr. Patton praised the experience of the Delaware bench, stating that they provide "the opportunity to go to a court with a great deal of depth and a great deal of experience."    He said that if state of incorporation venue was abolished

We will never again be able to grow another forum with the depth of experience and body of case law.   There will be no other place where cases can be concentrated.  

(Ed.:    Do you hear the refrain of "My judge is better than your judge, my judge is better than yours, my judge is better 'cause he's from Delaware, my judge is better than yours"?).

He also argued for predictability, stating:

We can argue about whether "law shopping" is a good thing or a bad thing, but loss of flexibility means less chances to maximize value for stakeholders.

(Ed.:  law shopping refers to the practice of filing in a venue where judges take the legal position that you favor.  It is a variant on forum shopping).   

Mr. Patton argued that requests for transfer of venue are "granted far more often than denied" and that cases with "a clear center of gravity" are being adequately addressed through transfer of venue.

Finally, he said that principal place of business would not eliminate forum shopping, pointing to a survey of 50,000 companies which had an average of 15 headquarters each.   

In response to a question from Commissioner Deborah Williamson, Mr. Patton admitted that Delaware's local counsel rule was outdated.

Michael Luskin, appearing on behalf of the New York City Bar Association's Committee on Bankruptcy and Corporate Reorganization bucked the prevailing mood when he boldly stated, "This is a solution in search of a problem.   There is no problem."    He argued that the current system "as applied by judges and practitioners serves efficiency and justice" and that "cases get transferred when they need to be."

Like his colleague from Delaware, Mr. Luskin raised the specter that a nerve center test would lead to endless litigation.

His suggestion was to ensure that all constituencies be represented through committees.    He said that committees are able to find superb representation for cases in Delaware and New York which protects parties.   He also said that "what's important" is that parties are able to "participate in a meaningful way" in negotiating the DIP order, plan and exit financing.   

Mr. Luskin pointed out that while airline cases have been filed across the country, the same firm represents the employees regardless of where the case is filed.

He said that "it is a fact that you can't run from" that people don't have a problem traveling to New York.

Luskin also sang the praises of the New York court, stating that it is a great advantage to have a case administered by a court that has a deep bench and where "the whole courthouse is set up for it."    

He said that another solution would be televising hearings much as the ABI Commission hearing was being livestreamed. Judge Rhodes pointed out that the current policy of the administrative office of the courts prevents audio or video broadcasting of court proceedings. He said that he requested permission to broadcast hearings in the City of Detroit case and was turned down.

Thinking Outside the Box

Each of the five venue panelists was asked to step outside of the box and propose a solution other than their proposed resolution.

Judge Rhodes said that having a national bankruptcy court process might be a solution but that "the devil is in the details."     He also suggested re-examining the appellate structure for bankruptcy courts to avoid avoid law shopping.    

Douglas Rosner said that a possibility would be making principal place of business the presumptive choice and placing the burden on the debtor to justify a filing elsewhere.    

Prof. Westbrook said that a national bankruptcy court was not the solution, even if judges were appointed from across the country, because it would not solve the problem of engaging the local community.   

James Patton said that the community problem would not be solved by venue reform because "there's always going to be a choice."   He suggested having a hearing at the beginning of a case to determine whether there is a better place to administer the case and what could be done to make the present venue a better place.   He gave the example of a Delaware case involving a Florida debtor where local Florida officials wanted the case transferred but other parties, including Florida creditors, did not want the case transferred.   In that instance, the court did not transfer venue but did order that the debtor pay for first class plane tickets and hotel accommodations for the local officials so that they could attend the proceedings.   

Mr. Luskin suggested that they should make it easier to get to court.   He proposed a system of national admission.   He said he was "horrified" to hear that the judicial conference prohibited broadcasting  and said "I can't think of a single reason not to do that."  He also went back to his suggestion to have more committees.    (Ed.:  Was it Marie Antoinette who said, "Let them have committees?").   

Commissioner James Markus asked Judge Rhodes about how his experience with the City of Detroit Chapter 9 bankruptcy compared to Chapter 11.

Judge Rhodes said that the City of Detroit case illustrated two points about the importance of having cases in the local community.

First, he said, citizens came to every hearing.   He used the largest courtroom available to him as well as two overflow rooms where citizens could watch on closed-circuit television.   (Apparently this does not constitute broadcasting).    He said that the citizens who came were very attentive and very interested in everything that occurred.

Second, he said that he devoted a full day to hearing remarks from 90 citizens who filed pro se objections to the City's eligibility for chapter 9.    Judge Rhodes said that the citizen comments were thoughtful, objective and angry and that he found them to be "of extraordinary value."    The Judge added that it was "an extraordinary day of process" and that he was "as grateful as I could be to have participated in that day."   

Closing Thoughts

The venue discussion was lively and thoughtful.   The advocates for change focused on the political and social values that are lost when cases are heard in distant forums while the advocates for the status quo argued that they had superior courts which knew how to transfer venue when it was needed.    As I have disclosed above, I am biased in favor of Texas companies filing bankruptcy in Texas, and yes, part of the reason is that I would like to see Texas firms get the work.   I thought that the Delaware and New York representatives were a bit patronizing toward judges in the rest of the country.   I have no doubt that there are some really good judges in Delaware and New York.   However, what does that make the judges in the other 88 districts?    Are they so sub-par that big cases have to be kept out of their reach?   I don't think so.   Also, I don't buy the argument that it is so easy to transfer venue.  According to James Patton, the Delaware Courts granted motions to transfer venue in nine out of thirteen cases between 2006 and 2012.   The fact that only two venue transfer motions per year are filed in Delaware says something.   It could say that most people feel that Delaware is a superior forum and are happy to have their case litigated there.   However, I think it is more likely that most creditors are too intimidated to hire a Delaware lawyer to tell a Delaware Judge that the case should be somewhere else.   

While Mr. Luskin believes that no one has a problem traveling to New York,  that doesn't mean that it is affordable for small creditors to travel to Delaware or New York.   Delaware is a poster child for parochialism.   Its local counsel requirement (which Mr. Patton agreed was outmoded) requires creditors wanting to appear in that court to hire an attorney with an office in Delaware.  To get to Delaware, it is necessary to fly into Philadelphia and take a 30 mile ride by car or limo.   New York has much better access.   However, once you get there, a hotel will run you $250-$400/night.  

I can somewhat understand the argument for filing large cases in the Southern District of New York.  New York is a major center of commerce, but so are Houston, Chicago and Los Angeles.  And Delaware:  Delaware is a state where companies go to incorporate   While half of the companies in the counrty are incorporated in Delaware, only two Fortune 500 companies have their headquarters there, compared to 53 in California, 52 in Texas, 50 in New York and 32 in Illinois.  Having two Fortune 500 companies located there places Delaware on a par with such states as Oregon and Rhode Island.   What Delaware does have is friendly corporation and tax laws.   According to the New York Times, the Cayman Islands complain that "Delaware is today playing faster and looser than the offshore jurisdictions that raise hackles in Washington."   Thus, while the Delaware courts possess a certain expertise, this is as a result of an historical accident favoring incorporation there. However, Nevada is also gaining a reputation as a tax haven.   I wonder whether the proponents of state of incorporation venue would be quite so bullish on this theory if Nevada started to usurp their business.  

Thinking Outside of the Box on Venue

One benefit of attending conferences is that sometimes you get something unexpected.   That happened at the Commercial Law League’s New York meeting when the discussion turned to venue.   The CLLA has staked out a position in favor of venue reform.   You can read the testimony of Peter Califano on behalf of the League here.   However, the discussion raised the question of whether more radical reforms are appropriate to address the problem of venue in cases of national interest.

While the Commercial Law League represents the interest of creditors in general, it has a special focus on the rights of smaller unsecured creditors.   The fact is that it is more expensive and more inconvenient for smaller creditors to appear in New York or Delaware.   There is also a personal economic interest for some league lawyers.   Speaking only for myself, I cringe when I see a case with strong Texas ties, such as Enron or American Airlines, filed on the East Coast.   However, venue abuse cuts both ways.    One of the largest cases to file in Austin recently was based in North Carolina.    Corpus Christi, Texas has become a magnet for significant cases despite the fact that it is just a small city on the Texas coast.    It is not an unreasonable proposition to argue that that the venue laws in bankruptcy cases have become so porous that debtors and their lenders are relatively free to choose whichever forum they prefer, or, to put it more directly, we have a system of rampant forum shopping.

However, this discussion presumes that for each debtor, there is a “right” forum instead of Delaware or New York.   In many cases, there will be a “right” forum.   Enron was a Houston-based company whose failure had a disproportionate impact upon Texas.   It is telling that the criminal trials arising from Enron all took place in Houston.   (I remember this well because we had to get past all of the TV trucks to make it to bankruptcy court).    However, where a network of companies has operations in multiple states and the case is of national importance, there may be more than one “right” forum.   

When a company’s case will impact multiple states, which should get to decide where the case will come to rest?   Once a case has been filed and hearings have been held, the forces of inertia are likely to keep it where it landed initially.  One suggestion raised at the Commercial Law League meeting was to treat multi-state cases similarly to Multi-District Litigation in federal court.   Under 28 U.S.C. Sec. 1407, the Judicial Panel on Multidistrict Litigation has the authority to decide whether to consolidate cases under MDL and to transfer them for purposes of pretrial proceedings and discovery.   If not resolved prior to trial, the cases are sent back to the original forum for trial.

Another possibility would be to take a cue from Chapter 15.  Under chapter 15, courts look for the Center of Main Interest, which refers to where a company’s main economic activity is.  A “main” case filed in another forum can seek recognition in this country.   By analogy, when a company such as American Airlines filed bankruptcy, there would be a procedure to determine its Center of Main Interest.   Once that was determined, that district would be the lead district.   However, ancillary proceedings could be opened in other states.  

 

Under either one of these options, there would be a procedure for judges to determine which district had the most significant interest in the case rather than allowing the parties to simply pick a venue.    The Enron case is a good example.   It filed its petition in the Southern District of New York because it had a minor subsidiary there.   Under the procedure described here, upon filing in New York, there would immediately be a hearing set to determine where the case would proceed.   It would not be necessary for a party, such as the Texas Attorney General, to move for transfer of venue and wait for a hearing.   Upon a finding that Texas was the Center of Main Interest, the case would immediately be transferred to Texas or, in the alternative, and a main proceeding could be established in Texas and an ancillary proceeding in New York.   The judges in Texas and New York could cooperate to ensure that Texas-centric issues were decided in Texas and New York-based issues were based in New York.

To facilitate a scheme such as this, it might be necessary to establish “Super Judges” (who would wear tights and a cape) in each state or circuit who would be qualified to handle cases of national importance.   In Texas, Barbara Houser would be a logical candidate.    By creating a “National Case Panel” it would be possible to both ensure that there was a cadre of qualified judges, but also have judges who would regularly confer with their brethren in other states and circuits to be prepare to handle cases with multi-state impact.

Another thought-provoking issue raised was whether circuit splits were contributing to forum shopping.   It was suggested that Sixth Circuit precedent is unusually favorable to successor liability claims.    With such precedent out there, a company such as Chrysler or GM might be deterred from filing in the Sixth Circuit.   The Ninth Circuit has In re Catapult Entertainment, Inc., 165 F.3d 747 (9^th Cir. 1999), which might deter companies with intellectual property issues from filing in the Ninth Circuit.   

As noted by Judge Guy Cole at the NCBJ conference, circuit judges spend most of their time hearing criminal cases and prisoner appeals, while very little of their time is spent on bankruptcy.   As bankruptcy courts become our national commerce courts, it might be desirable to have a single court of appeals with jurisdiction over issues of pure bankruptcy law.   For example, patent appeals go before the Federal Circuit.   Is it unreasonable to suggest that bankruptcy appeals should similarly go to a specialized appellate court?   This would not be workable for many bankruptcy appeals which depend on the vagaries of state law.   However, it might be desirable to create a panel of circuit judges with expertise in bankruptcy matters to whom important bankruptcy cases could be referred in order to create a national rule short of involving the Supreme Court (which only hears a few bankruptcy cases a year).

These thoughts (which may not reflect the ideas of the original speaker) may be impractical, unworkable and unrealistic.   However, I think it is worth discussing whether it is time to develop Bankruptcy 3.0 for cases and issues of national importance.   As a practitioner, I get frustrated with our current ad hoc system of venue.   Legislation fixing where to file may not be enough to solve the problem if it is too easy to bypass the legislative criteria.   I would prefer to see some judicial supervision of where big cases get filed as opposed to letting big debtors and their banks decide who gets to have all the fun.